Joseph Krist

Publisher

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ISSUE OF THE WEEK

$10,245,000*

SOUTH CAROLINA JOBS-ECONOMIC DEVELOPMENT AUTHORITY

Solid Waste Disposal Revenue Bonds

(Ridgeland Pellet Company, LLC Project)

As we move through the interest rate cycle, we are not surprised to see yet another high yield issue for a relatively untested technology project financing being foisted on the municipal bond market. In this case, the project is designed to produce wood pellets for use as heating fuel overseas. The fuel for the pellets is wood waste produced at sawmills.

Some projects in this sector have been economically viable but the experience with these sorts of projects in the municipal bond space have been decidedly negative. Whether it be for use as fuel or for conversion into products such as medium density fiberboard, the municipal market is littered with a trail of failed projects of this type. As is often the case, the security for the debt is the project itself. The corporate entity operating the plant was newly established in January of this year so there are no other substantial assets behind the project.

The investors once again are being asked to assume all of the construction and operating and financial risk of the project. It has been my experience that these deals are financed in the municipal market after the traditional taxable financing sources have passed on the opportunity. One always has to wonder why operators who have supposedly executed similar successful projects have taken this financing route. This is especially true when a smaller scale individually owned business shifts its source of financing from its traditional sources to the municipal market.

Whenever it occurs at the later point of an economic cycle when interest rates are trending upward, warning lights should go off. Deals in the municipal high yield space that have these characteristics when refinancing options are limited and the perception of overall economic risk is greater present a situation that should motivate investors to strike as hard a deal as possible to mitigate these concerns. Unfortunately, the supply/demand dynamics of the municipal high yield market often result in a deal more favorable for the project rather than for the investor. Caveat emptor!

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BRIGHTLINE

We continue to watch the rollout of the Brightline high speed rail service in Florida from a number of vantage points. The development of successful service would of course mark an important milestone in the evolution of mass transit in the country. Coming at a time of rapid technological change in the transportation sector, the success of this service on a sustainable basis would put the US in a better position to catch up with much of the industrialized world in terms of its long distance passenger rail service.

What interests us about the Brightline story is its continued insistence that it is a privately financed project even as it continues its intense efforts to obtain tax exempt financing for its construction. Those efforts continue as Brightline seeks to complete its expansion from the east coast of Florida to Orlando. Even as the long term outlook for the sustained financial viability of the project, its sponsors are already moving on to additional frontiers for its ambitions.

Now sponsors are pushing for an expansion of service from Orlando to Tampa and are mentioning the potential for projects in other states such as Texas. What we are to make of this is unclear, as the information on passenger utilization and revenues has yet to show that the existing Miami to Palm Beach service corridor is producing a long term viable framework on which expansion can be supported. Suffice to say that we remain unconvinced as the service remains in the “novelty” phase including a substantial publicity effort and promotional pricing.

ARIZONA

Supporters of The Invest in Education Act announced that they have collected enough signatures to put the question on the ballot in November.  The measure proposes raising the income tax rate from 4.5 percent to 8 percent for people  making at least $250,000 and for families earning at least $500,000. For individuals making $500,000 and joint filers making $1 million, the tax rate would be 9 percent. If passed, the tax is projected to raise $690 million annually for teacher salaries and supplies, as well as restoring full-day kindergarten and reducing class sizes.

In May, Gov. Doug Ducey signed a budget giving teachers a 20 percent pay raise over three years plus more than $300 million in discretionary funds over that period. Ducey’s “20 by 2020 plan” is expected to cost $240 million this fiscal year, increasing to $580 million by 2021. The Governor’s plan is based on a new car registration fee of about $18 per vehicle, which is expected to generate an extra $140 million per year.

The governor has repeatedly said he would not support a tax hike on Arizonans.  A telephone poll conducted three weeks after the teacher strike ended found that 65 percent of voters said they would support the initiative in November.

MEDICAID

The ACA has been given up for dead many times but there continues to be momentum for expansion of Medicaid. The latest example is in conservative Nebraska where an activist group seeking Medicaid expansion in Nebraska, announced  that it had gathered more than 133,000 signatures in support of a ballot initiative to authorize the expansion.  85,000 valid signatures are required to put the proposal on the ballot.

The initiative would extend Medicaid coverage to some 90,000 Nebraska residents, who currently do not qualify for the program but have difficulty purchasing health care on their own through the Affordable Care Act. The state will join Idaho and Utah with a Medicaid expansion initiative on its ballot. The initiative is an effort to get around the steadfast opposition to expansion expressed by the state’s governor.

Mississippi has revamped its request to impose work requirements on its Medicaid beneficiaries, a move to address federal concerns that its original proposal would have left some without insurance. In the overhauled proposal, Mississippi guarantees beneficiaries will receive up to 24 months of coverage if they comply with the proposed work requirements, which include working at least 20 hours per week, volunteering or participating in an alcohol or other drug abuse treatment program. Mississippi submitted its initial request late last year.

CALIFORNIA

California received more tax revenue than expected during the month of June and for the 2017-18 fiscal year, which ended June 30. Total revenues of $19.91 billion for June were greater than anticipated in the budget signed in June 2017 by $2.30 billion or 13.1 percent. All of the “big three” revenue sources came in higher than projected. Overall revenues for FY 2017-18 of $135.29 billion were $1.53 billion more than estimates in the May budget revision and $6.82 billion higher than expected in the 2017-18 Budget Act. Total fiscal year revenues were $13.38 billion higher than in FY 2016-17.

For June, personal income tax (PIT) receipts of $12.57 billion were $691.8 million, or 5.8 percent, higher than estimated in the budget proposal released in May. For the fiscal year, PIT receipts of $93.48 billion were $4.34 billion, or 4.9 percent, more than projected in the 2017-18 Budget Act. June corporation taxes of $3.23 billion were $577.2 million, or 21.7 percent, above assumptions in the governor’s May budget proposal. For the fiscal year, total corporation tax receipts were 14.8 percent above assumptions in the enacted budget. Sales tax receipts of $3.15 billion for June were $759.0 million, or 31.8 percent, more than anticipated in the governor’s FY 2018-19 amended budget proposal. For the fiscal year, sales tax receipts were 2.0 percent higher than expectations in the 2017-18 Budget Act.

At the conclusion of FY 2017-18, the state’s General Fund had $10.38 billion more in receipts than disbursements, and $4.84 billion were used to repay outstanding loans from the previous fiscal year. At the end of June, there were $39.93 billion available for internal borrowing from the state’s own funds, which was more than anticipated in the May budget proposal by $1.81 billion.

PUERTO RICO

The government of Puerto Rico sued Puerto Rico’s Financial Oversight and Management Board for attempting to “usurp” the island government’s powers and right to home-rule. The suit is the government’s response to the fiscal board’s rejection of an $8.7 billion budget passed by the legislature, contending it was not compliant with the commonwealth fiscal plan the panel certified. The board proceeded to impose its own budget, which cuts funds for municipalities and workers’ year-end pay, known as the Christmas bonus.

The suit outlines the Government’s position. “The Oversight Board cannot compel the Governor to comply with its policy recommendations, whether those recommendations are free-standing or advanced in a fiscal plan. And the Board certainly cannot force those recommendations on the Commonwealth via a budget. Specifically, the Oversight Board cannot do what it is attempting to do: impose mandatory workforce reductions, change the roles and responsibilities of certain government officials, criminalize certain acts under Puerto Rico law and otherwise seek to micromanage Puerto Rico’s government.”

The suit seeks a ruling declaring that the “substantive policy mandates” in the board’s budget exceed the oversight panel’s “powers and are null and void,” as well as a ruling “enjoining the Oversight Board from implementing and enforcing the Oversight Board’s rejected policy recommendations.” As is nearly always the case, Puerto Rico seeks special treatment. For example, the District of Columbia Financial Responsibility and Management Assistance Act of 1995, which granted the District of Columbia’s Financial Control Board the power to nullify legislative acts and “compel the mayor and city council to adopt its policy recommendations”.

The suit accuses the PROMESA board of attempting to micromanage Puerto Rico’s fiscal affairs. In our view, micromanagement is what Puerto Rico needs. We have asked in a variety of forums why Puerto Rico’s American citizens should be exempt from such supervision when numerous mainland jurisdictions have operated under it. It is a question which never receives an answer. This makes it hard to support the Puerto Rico government’s position as it seeks to regain market access and has multi-billions of defaulted debt outstanding.

FITCH RATINGS ON HOSPITALS

A request from the Lexington County Health Services District, Inc., SC (the district) on behalf of Lexington Medical Center (LMC) to Fitch to withdraw its non-investment grade rating has served to highlight changes to Fitch’s rating criteria for hospital credits. Under the revised criteria, Fitch includes operating leases and net pension liabilities as debt equivalents when assessing a hospital’s leverage profile.

The District’s debt had been rated A+ by Fitch as recently as November, 2017. The application of the new criteria resulted in a new rating of BB+. LMC’s management did not participate in the rating process for this review. The below investment grade rating was applied despite “strong medical and surgical volume growth as a result of successful expansion strategies with a highly integrated physician platform and ambulatory network and further bolstered by population growth in the county.” Fitch also notes that the district returned to strong double digit operating EBITDA margins on an unaudited basis in 2017 and currently in unaudited 2018.

Fitch applied a 20 year period to achieve full pension funding. This is shorter than the 30 year period used by many municipal issuers. Complicating the hospitals position is its status as a governmental entity which participates in state managed pension plans. The District is therefore limited in its ability to alter its pension position outside of actions to spend more currently on pension contributions.

As a result of all of this, the District has asked for the rating to be withdrawn. We see the basis for Fitch’s actions and do not argue that the A+ rating was no longer warranted under the terms of Fitch’s methodology. Whether or not, an enterprise which is projected to produce operating EBITDA margins of approximately 5% to 5.5% in the coming years net of pension contributions is deserving of a speculative grade rating is another issue.

We are not surprised at the request to withdraw the rating. We do not see this sort of pension funding assumption applied to many other credit sectors, so it is understandable that this issuer would exercise such a request. A six notch downgrade does seem to be excessive.

TRUCKERS SUE AGAINST TOLLS IN RHODE ISLAND

In June of this year, the State of Rhode Island began charging tolls on trucks using the major highway in the State. Under the plan, which was signed into law back in 2016, 18-wheelers will pay up to $20 to cross the state traveling on Interstate 95. A single truck will be capped at paying $40 a day.

The tolls are intended to finance a 10-year plan to repair deteriorating bridges in the Ocean State; Rhode Island has the highest percentage of structurally deficient bridges in the country. The tolls, to be collected electronically via 14 gantries, are expected to bring in around $45 million a year once they are up and running.

The scheme seeks to impose costs on those vehicles which contribute to the most wear and tear on roads as well as to address congestion issues. The American Trucking Association and three companies  said the toll system launched last month discriminates against out-of-state trucking companies, violating the commerce clause of the  U.S. Constitution.

It asks a judge to stop the tolls, now operating at two locations on Route 95 in Washington County, and eventually slated to include 14 tolls throughout the state. The two Route 95 tolls charge $3.25 and $3.50 respectively, so 133,000 transactions would result in somewhere in the neighborhood of $450,000 in charges since the system has been running.

The toll program is but one step in efforts at the state level to develop usage based schemes for road users in the face of inaction at the federal level to finance infrastructure. It would seem to be the type of effort supported by the Trump Administration as it seeks to move the finance of infrastructure to a fee based model and to increase the role of the private sector in infrastructure development and execution.

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